Internally Generated Assets and the Challenges in Capitalisation

Internally generated intangible assets are a significant aspect of modern business operations, particularly in industries focused on tech and innovation. These assets, which include items such as platforms, software, patents, and trademarks, are created within the company rather than acquired from external sources. While they can provide substantial economic benefits, the process of capitalising these assets presents several challenges.
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Definition of an Intangible Asset

The definition of an intangible asset in accordance with IAS 38 is “an identifiable non-monetary asset without physical substance”.  An intangible asset should be recognised in the financial statements once it is probable that future economic benefits attributable to the asset will flow to the entity and the cost of the asset can be measured reliably.

Challenges in Capitalisation

Despite the clear guidelines, recognising internally generated intangible assets poses several challenges. One of the primary issues is the reliable measurement of the asset’s cost. Development activities often involve uncertainty and may not be easily distinguished from the costs of day-to-day operations of the business. Additionally, the probability of future economic benefits requires a thorough assessment of the asset’s potential which is not always possible at the development stage.

Recognition Criteria

Due to the above, entities are required to classify costs as either ‘research’ or ‘development’.

While research involves original, planned investigations, development pertains to applying the findings of research to devise plans for creating or enhancing processes and systems.

Research activities are never capitalised and always expensed, however, development activities may be capitalised if they satisfy the specific recognition criteria.

IAS 38 outlines 6 criteria that must be satisfied for an internally generated intangible asset to be recognised,

• It is probable that future economic benefits attributable to the asset will flow to the entity.
• There is an intention to complete the intangible asset and use or sell it.
• Adequate resources are available to complete, use, and sell the asset.
• There is an ability to use or sell the intangible asset.
• Technically feasible to complete the asset.
• Cost of the asset may be estimated reliably.

Once all criteria are met, the costs associated with the development of the internally generated intangible asset can start being capitalised.

Measurement

Internally generated intangibles are measured at cost (once the criteria have been satisfied).  The cost includes all directly attributable costs, including but not limited to costs of materials arising from the generation of the asset, salaries of people involved in development & legal fees.

Costs incurred after completion of development are expensed.

This area has been criticised by the financial reporting community since assets are only recognised towards the end of the development process meaning that the value allocated is typically lower than the actual expected economic benefit to be derived from that asset.

Conclusion

The standard was written before the growth of modern technological companies and so it does not adequately consider their needs and realities.

Internally generated intangible assets are significant parts of a company’s asset portfolio. However, the process of capitalising these assets is fraught with challenges, including reliable measurement and the distinction between capitalisable costs and expenses.